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Microfoundations of Two-sided Markets: The Payment Card Example

  • James McAndrews
  • Zhu Wang

This paper provides a theory of two-sided market dynamics with arguably better microfoundations. These alternative microfoundations focus on observable heterogeneities of both sides of the market in a competitive framework. The theory is rich in empirical predictions and is less dependent on a particular form of imperfect competition than other approaches. Our findings in the payment card example point to adoption costs and the distribution of consumer incomes and firm sizes as the key determinants of the shares of costs borne by each side. This result provides clear implications for industry dynamics and sheds light on the puzzle of asymmetric pricing.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 128.

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Date of creation: Jan 2007
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Handle: RePEc:dnb:dnbwpp:128
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  1. Richard J. Sullivan & Zhu Wang, 2005. "Internet banking: an exploration in technology diffusion and impact," Payments System Research Working Paper PSR WP 05-05, Federal Reserve Bank of Kansas City.
  2. Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
  3. Schwartz Marius & Vincent Daniel R., 2006. "The No Surcharge Rule and Card User Rebates: Vertical Control by a Payment Network," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-31, March.
  4. Fumiko Hayashi, 2004. "A puzzle of card payment pricing : why are merchants still accepting card payments?," Payments System Research Working Paper PSR WP 04-02, Federal Reserve Bank of Kansas City.
  5. Comin, D. & Hobijn, B., 2004. "Cross-country technology adoption: making the theories face the facts," Journal of Monetary Economics, Elsevier, vol. 51(1), pages 39-83, January.
  6. Jovanovic, B. & MacDonald, G.M., 1992. "The Life-Cycle of Competitive Industry," Papers 92-09, Rochester, Business - Financial Research and Policy Studies.
  7. Allen N. Berger & Loretta J. Mester, 2001. "Explaining the Dramatic Changes in Performance of U.S. Banks: Technological Change, Deregulation and Dynamic Changes in Competition," Center for Financial Institutions Working Papers 01-22, Wharton School Center for Financial Institutions, University of Pennsylvania.
  8. repec:rne:rneart:v:5:y:2006:i:1:p:71-102 is not listed on IDEAS
  9. Richard J. Sullivan, 2000. "How has the adoption of Internet banking affected performance and risk in banks?," Financial Industry Perspectives, Federal Reserve Bank of Kansas City, issue Dec, pages 1-16.
  10. Mark Armstrong, 2005. "Competition in Two-Sided Markets," Industrial Organization 0505009, EconWPA.
  11. Rodolfo E. Manuelli & Ananth Seshadri, 2013. "Frictionless technology diffusion: the case of tractors," Working Papers 2013-022, Federal Reserve Bank of St. Louis.
  12. Evans, David & Schmalensee, Richard, 2005. "The Economics of Interchange Fees and Their Regulation: An Overview," Working papers 18181, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  13. Kevin J. Stiroh, 2001. "Information technology and the U.S. productivity revival: what do the industry data say?," Staff Reports 115, Federal Reserve Bank of New York.
  14. Stuart E. Weiner & Julian Wright, 2005. "Interchange fees in various countries: developments and determinants," Payments System Research Working Paper PSR WP 05-01, Federal Reserve Bank of Kansas City.
  15. Rochet Jean-Charles, 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-28, June.
  16. Jean-Charles Rochet & Jean Tirole, 2006. "Externalities and Regulations in Card Payment Systems," Post-Print hal-00173720, HAL.
  17. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
  18. Zhu Wang, 2006. "Learning, diffusion and the industry life cycle," Payments System Research Working Paper PSR WP 04-01, Federal Reserve Bank of Kansas City.
  19. Sujit Chakravorti, 2003. "Theory of credit card networks: a survey of the literature," Payment Cards Center Discussion Paper 03-09, Federal Reserve Bank of Philadelphia.
  20. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
  21. repec:reg:rpubli:105 is not listed on IDEAS
  22. Julian Wright, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Industrial Organization 0108001, EconWPA.
  23. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  24. Courchane, Marsha & Nickerson, David & Sullivan, Richard, 2002. "Investment in internet banking as a real option: theory and tests," Journal of Multinational Financial Management, Elsevier, vol. 12(4-5), pages 347-363.
  25. Zhu Wang, 2006. "Technology Innovation and Market Turbulence: A Dotcom Example," 2006 Meeting Papers 508, Society for Economic Dynamics.
  26. Jean-Charles Rochet & Jean Tirole, 2002. "Cooperation Among Competitors: Some Economics Of Payment Card Associations," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 549-570, Winter.
  27. Richard Sullivan, 2004. "Payment services and the evolution of Internet banking," Payments System Research Briefing, Federal Reserve Bank of Kansas City, issue Aug.
  28. Farrell Joseph, 2006. "Efficiency and Competition between Payment Instruments," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-19, March.
  29. Jean-Charles Rochet & Jean Tirole, 2007. "Must-Take Cards and the Tourist Test," DNB Working Papers 127, Netherlands Central Bank, Research Department.
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